Assignment#2

Business Finance

By: Akshat Bansal

Anurag
Swathi
Ritesh
Priya
Question 1 (A): A bond with face value of Rs.10,000 has a maturity of 10 years, and coupon of
11%. If its yield to maturity (YTM) is 9%, then determine the price of bond.

Answer: The formula to calculate the price of bond is as follows:

P = C1/(1+R)^1+ C1/(1+R)^2+…+ Cn+RV/(1+R)^n
Where:
P = Price of the bond
Cn= Coupon of nth period
RV= Redemption Value
R= Discount Rate or YTM
After using the above formula, the price of the bond is Rs. 11283.53154
Note: Please refer to the excel sheet for calculation (Sheet Name: Q 1A)

1(b). A bond is traded at a price of Rs. 1,080.42. It has a face value of Rs. 1,000, a semi-annual
coupon of Rs. 30, and a maturity of five years. Determine its yield to maturity.
Answer:
A bond is traded at a price of Rs. 1,080.42.
It has a face value of Rs. 1,000, a semi-annual coupon of Rs. 30, and a maturity of five years.
Determine its yield to maturity.

Return on bond is understood in the sense of Yield To Maturity

Return on security (YTM) is that discount rate which makes the present value of future cash inflows
from a bond equal to the present price of a bond over its maturity period.

Return on bond is understood in the sense of Yield to Maturity and is defined as that discount rate
which equates the present value of cash flows from a bond to its price.
Valuation of a bond is done here by taking the present valuation of future cash flows from a bond
using YTM as a discount rate.
Hence in the given problem, the give date is as follows:
Face value = Rs 1000
Annual coupon=Rs 60
Price of the bond=Rs. 1,080.42
Redemption value = Rs 1000
To determine:
r (discount rate) or Y (Yield to Maturity) or Internal Rate of Return (IRR) is to be determined
Formula:
P=c1/(1+Y)^1+ c2/(1+Y)^2+...+(c5 +RV)/(1+Y)^5
Rs.1080.42 = 60/(1+Y)^1 + 60/(1+Y)^2+ ….+(60 +1000)/(1+Y)^5
IRR is based on the Assumption that all reinvestments will be done at the same rate YTM is also based
on the same assumption whatever we are getting during the tenure of the bond, in our case 5 years,
will be reinvested at a same rate ( IRR) or same (YTM) and reinvestment rate will be same throughout.
Year Cash flows
0 -1080.42
1 60.00
2 60.00
3 60.00
4 60.00
5 1060.00
IRR 4.18%

YTM =4.18%
Since the coupon rate (6%) is more than the YTM (4.18%) if the maturity period goes higher the price
of the bond will increase higher.
Note: Please refer to the excel sheet for calculation (Sheet Name: Q 1B)

Question 2: Answer the following with your reasonings and state your assumptions clearly (if
any)
Shivam Rubber Ltd. is expected to pay a dividend of 20% in the upcoming year on a share with
a face value of Rs. 10. Dividends are expected to grow at the rate of 6% per year. The risk-free
rate of return is 5% and the expected return on the market portfolio is 13%. The share of the
Company has a beta of 1.2. You are required to determine the intrinsic value of the share of
the company and give your reasoning for arriving at the value.

Answer
Expected Return= Risk Free Rate + (Market Return- Risk free Rate) * Beta
Risk free rate=5%
Market return=13%
Beta=1.2
Expected return = 5+ (13-5)*1.2
= 14.6%
As per Dividend discount model with constant growth rate,
Price of stock= Dividend per share/(Expected return- growth rate)
Dividend per share= 20% of Rs.10(face value)
= Rs. 2
Price of stock= 2/(14.6%-6%)=2/(.146-.06)= Rs.23.25
This is the intrinsic value of the share of the company based on the dividend discount model with
constant growth rate.
Some of the assumptions associated with this model which will hold true in the determination for the
above problem as well are:
a. We have perfect knowledge about all future dividends
b. It is possible to extrapolate the past performance the company into the future with 100% accuracy
c. The share price is entirely decided due to expected future cash flows (dividends) and capital growth,
assets, patents etc. are completely disregarded
d. The Cost of capital (i.e. required return) is known and remains constant
e. You know precisely how much dividends will grow (% annually) until liquidation, or forever.
f. Investors are rational

Question 3 - The Group is provided with the last 5-year financial information of NTPC Limited
along with their approximately last 5 years share prices.
Click here to access the excel.
Click here to access the 5-year financial information of NTPC
(Use Capital Assets Pricing Model (CAPM) to estimate its cost of Equity – Cost of Equity = Risk-
Free Rate+(Market Rate - Risk-Free Rate) x Beta; For Market Return use BSE SENSEX (data is
provided) and take risk-free rate as 6.65% per annum. For calculating the Market Annual
Return from Daily returns, use 250 as the number of working days. Also, use the following
formula to calculate return from prices
Return = [(Price today – Price of the previous day)/ Price of the previous day]
Required:
a) Valuation of the Company using Dividend Discount Model (use only constant growth
model) Dividend Data is given in the attached EXCEL file. While calculating the intrinsic value
of NTPC share, use the formula g = Return on Equity ´Retention Rate to calculate the growth
rate. After the calculation of growth rate then compute valuation using the Dividend Discount
Model.
Answer:
Step1: Calculating Cost of Equity
Cost of Equity has been calculated using the formula given,
Cost of Equity = Risk-Free Rate+ (Market Rate - Risk-Free Rate) x Beta
Share prices were given for the years from 2016 till 2021.

Assumption – Since, Mean Return and Standard Deviation are calculated annualized, calculating for
the entire data, and then multiplying with 250 days per year, will not be appropriate. So, calculated
Cost of Equity for every year separately.

Year 2019-20 2018-19 2017-18 2016-17 2015-16

Cost of Equity 15.33% 10.25% 6.63% 19.36% 3.81%

Step 2: Valuation of Shares

Profit After Tax (PAT) and Net Worth are pulled from the given financial information.

Return on Equity (ROE) is calculated by PAT/Net Worth.

Amount of dividend paid is calculated from the dividend table by multiplying Dividend Rate and Face
Value.

Dividend Payout Ratio is calculated - dividing Amount of Dividend paid by PAT. As Earnings per Share
was not provided for 3A, calculated using this other formula.

Retention Rate = 1 – Dividend Payout Ratio

Growth Rate (g) = Return on Equity * Retention Rate

Valuation of the shares = [D0 (1 + g)]/ (k – g)

Assumption of the model is Growth rate (g) should be less than retention rate (k)

But, for the years 2019, 2018 and 2016, growth rate is higher than retention rates, so their share
value is also negative.

In the last year 2020 (as per the provided data in the financial information), value of the share of
NTPC is Rs. 30.86

Particulars 2019-20 2018-19 2017-18 2016-17 2015-16

Profit After Tax 5283.97 15591.23 7082.32 9121.34 10757.51

Calculation of Net
Worth of the
Company

Equity Share Capital 9894.56 9894.56 8245.46 8245.46 8245.46

Other Equity 103674.88 97513.61 93532.31 87985.77 83048.24

Net Worth 113569.44 107408.2 101777.8 96231.23 91293.7

 Return on Equity 4.65% 14.52% 6.96% 9.48% 11.78%

Dividend per share 3.15 6.08 5.12 4.78 3.35

Dividend Payout
Ratio 0.06% 0.04% 0.07% 0.05% 0.03%

Retention Rate 99.94% 99.96% 99.93% 99.95% 99.97%

Growth Rate 4.65% 14.51% 6.95% 9.47% 11.78%

Cost of Equity 15.33% 10.25% 6.63% 19.36% 3.81%

Value of the Share 30.86 -163.46 -1692.32 52.91 -46.96

If Cost of Equity is calculated on the whole,

2016-2020

BSE Sensex NTPC Ltd

Mean Return 0.06% -0.02%
Mean Return
13.87% -4.15%
(Annualized)
Variance 0.000132984 0.000288
Standard Deviation 1.15% 1.70%
Standard Deviation
288.30% 423.94%
(Annualized)

Beta 1 0.655

Risk-Free Return 6.65%

Cost of Equity 11.375%

Particulars 2019-20 2018-19 2017-18 2016-17 2015-16

Profit After Tax 5283.97 15591.23 7082.32 9121.34 10757.51

Calculation of Net
Worth of the Company

Equity Share Capital 9894.56 9894.56 8245.46 8245.46 8245.46

Other Equity 103674.88 97513.61 93532.31 87985.77 83048.24

Net Worth 113569.44 107408.2 101777.8 96231.23 91293.7

 Return on Equity 4.65% 14.52% 6.96% 9.48% 11.78%

Dividend per share 3.15 6.08 5.12 4.78 3.35

Dividend Payout Ratio 0.06% 0.04% 0.07% 0.05% 0.03%

Retention Rate 99.94% 99.96% 99.93% 99.95% 99.97%

Growth Rate 4.65% 14.51% 6.95% 9.47% 11.78%

Cost of Equity 15.33% 10.25% 6.63% 19.36% 3.81%

Cost of Equity for 2016-
2020 11.38% 11.38% 11.38% 11.38% 11.38%
-
Value of the Share 30.86 -163.46 1692.32 52.91 -46.96
Value of the Share with
same cost of equity 49.02 -222.07 123.85 275.21 -925.19

b) Relative Valuation of the Company uses Price/Earnings Ratio. (Calculate Price/Earnings

Ratio of last 5 years, take its average for the projection of next year’s (FY 2021) P/E, and
predict the price of the Company if it is expected that its EPS (Earning Per Share) will be Rs.
13.50. (Note: For Calculating relative valuation of the company 1. Calculate Price/Earnings
Ratio for the last 5 years using annual EPS and March-end price of each FY. 2- Number of
shares outstanding to be calculated by dividing share capital with the face value of the shares-
share capital/ face value per share)

Answer:

Price Per Earning = Market Price / Earnings per Share

Financial Year Earnings Per Share Market Price at the end of March P/E Ratio
FY 20-21 13.99 106.45 7.609
FY 19-20 10.22 84.2 8.238
FY 18-19 11.88 135.35 11.393
FY 17-18 10.45 169.7 16.239
FY 16-17 9.49 165.95 17.486

The market price of NTPC as on 20th May is 111.75

P/E Ratio = 111.75/13.5 = 8.278
To find the PE Ratio for financial year 21-22, we will take the average of last 5 years
= 60.966/13.5 = 12.193